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What are Sugar futures?
Hedgers
Speculators and
Arbitrageurs.
Hedgers are users who like to reduce the price risk they
face from potential price movements. Often, hedgers are
willing to sacrifice the potential upside to gain certainty
about prices.
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Sugar
Global Scenario
('000 tonnes,
raw value) 1999-2000 2000-01 2001-02 2002-03
Domestic
consumption 127,395 130,164 134,790 137,725
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Sugarcane is cultivated under tropical climates, while sugar
beet is grown in temperate regions. Around 75% of the
sugar produced in the world is from sugarcane, with beet
sugar accounting for the rest.
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Sugar: Forms of support adopted by different countries
Minimum Minimum Import Export Other
support sugarcane Controls Subsidies forms of
price for support Support
sugar price
EU India Brazil EU Australia
USA EU EU USA Brazil
China USA CUBA EU
USA Cuba South Africa USA
Japan Turkey Turkey Columbia
Thailand S. Africa India Cuba
Turkey Thailand Mexico
China Thailand
Japan S. Africa
Turkey
India
EU: European Union Source: CRIS INFAC
Note: This is only an indicative list
Import diversification
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sugar industry. In India, the sugar imports could be
reduced marginally, from the current level of 60%.
(At present, the customs duty in India is lower than the
WTO bound rate of 150%, and the customs duty of
most developed countries is higher)
With the likely removal of the levy quota and quarterly
free-sale quota release systems imposed on the
domestic producers, restrictions on sugar imports
would also have to be removed. As a result, sugar
prices in India would be aligned with the international
prices of sugar.
Given the likely increase in world sugar prices, with
the liberalization of the world sugar markets, import
pressures could be lower in India. Hence, domestic
prices of sugar could increase. In the long term,
export opportunities for efficient Indian sugar
producers would increase.
Slow response of demand - supply with respect to
changes in prices
Most of sugar consumption is in developed
countries
Developed countries have low or nearly zero
price elasticity because sugar consumption
accounts for a marginal proportion of their
disposable income
Consumption of sugar in developed countries is
in processed food form and the corporate buyers
of sugar in these countries ( food processors
like soft drinks, biscuits, confectionary producers)
are more concerned with preserving the market
shares of their products than the price of raw
material, sugar
Indian Scenario
India has been known as the original home of sugar and
sugarcane.Indian mythology supports the above fact as it
contains legends showing the origin of sugarcane.
In global sugar economy, the Indian sugar industry has
achieved a number of milestones.
Largest Sugar Producer in 7 out of 10 years
Second Largest Area under Cane/Cane Production
Amongst the cost-effective industries with its field cost
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(Sugar cane) being the second lowest, despite small
land-holdings and low productivity
Fourth efficient processor of sugar despite low
capacity of its sugar plants as compared to very large-
size plants in other parts of the world.
Sugar: India's share in global production
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INDIAN SUGAR INDUSTRY
Co-operatives
Private
Public
Sugarcane Production
Rationing
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Soil conditions
Availability of water
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cultivation accounts for around 5 % of the total irrigated
area.
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Sugar : Statewise Profile
Cane crushed
('000 tonnes) 11980 17303 53441 16645 59271
Duration of crushing
(days) 130 157 122 173 158
Cane production
('000 tonnes) 15387 32479 37015 30282 116324
Sugar production
('000 tonnes) 1210 1868 6219 1644 5651
Data pertains to 2002-03
Sugarcane
pressmud
Extraction of juice
Co-
Bagasse generation
of power
Clarification of juince
Evaporation
Pan-boiling
Crystallisation
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Extraction of the cane juice from the sugar cane, usually by
crushing the sugar cane (at this stage the sweet juice
contains many impurities - the soil from the fields, some
small fibers and green extracts from the plant)
After settling out much of the dirt and other impurities, the
juice is thickened into syrup by boiling off much of the
water (evaporation)
The syrup is placed into a very large pan for boiling and
more water is boiled off until conditions are right for sugar
crystals to grow
The final raw sugar is like a soft brown sugar and is stored
in a large sticky mountain. It can be used like that but usually
it gets dirty in storage and has a distinctive taste, which
most people don't want. That is why it is further refined to
produce white sugar for human consumption. Additionally,
because one cannot get all the sugar out of the juice, there
is a sweet by-product made - molasses.
By-products
There are essentially three main by-products generated
by the sugar industry.
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used in villages and by rural folk as sweetners and
also as important sources of nutrition.
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Sugar Demand in India
The demand for sugar is mainly dependent on
i. Population growth
ii. Income levels
Consumer preference for sugar vis-a-vis alternate
sweeteners
Being a basic commodity, the demand for sugar increases
with an increase in the population. The increase in per
capita income increases the demand for sugar. Between
1998-99 and 2002-03, consumption increased at a CAGR of
4.5%, due to an annual growth of 1.8% in population and
2.6% in per capita consumption of sugar.
Sugar : Trend in domestic consumption
i. Climatic factors
Sugarcane production
Recovery rate
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Sugar Contracts on NCDEX
Sugar (M Grade)
Futures Contract Specifications
Trading system NCDEX Trading System
Saturdays
Quotation/base
value Rs. per Quintal
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Grade : M
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Price Band Limit 10% or as specified by
Exchange from time to time. Limits
will not apply if the limit is reached
during final 30 minutes of trading
Sugar (S Grade)
Saturdays
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Quotation/base Rs. per Quintal
value
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Rationalization of sugarcane prices
Initiation of futures/forward trading.
Cane price rationalization is a vexatious issue that can take
years to resolve. It is obvious that sections of the sugar
sector perceive a threat that is why this has been added as
one of the conditions for decontrol.
Commercial prudence demanded that futures trading
follow, not precede, decontrol.
Hedging by itself cannot prevent an apprehended price
collapse in the context of the massive overhang of sugar
stocks unmatched by consumption demand. It is for the
mills to work out a common strategy to mitigate the rigours
of price fall. Indeed, the industry must realise that controls
can do more harm to the market - both physical and futures
- than a free-trade environment.
Immediate Decontrol
Earlier when the decontrol was first proposed in 1998 it
was expected that the sugar prices will come under
tremendous pressure as the industry was carrying huge
stocks. Sugar price were expected to decline by around
10% immediately after decontrol of the industry. It was
recommended by various committees that the price fall
can be controlled through setting up of futures trading
platform and Government announced sugar futures trading
a pre-requisite for decontrol.
The timing of announcing decontrol for sugar is most
propitious now.
There has been a sharp fall in domestic sugar production
in 2003-04 season to a recent low of 140 lakh tonnes down
from 201 lakh tones in the previous season. Closing stocks
at the end of 2003-04 are estimated at 84 lakh tonnes, again
the lowest in the last four years.
Clearly, the period of excess production and burdensome
stocks is over. In fact, imports of raw sugar are taking place
to meet a possible shortage. It is estimated that as much as
10 lakh tonnes have been contracted for and a sizeable
portion has already arrived on Indian ports.
The beet sugar production is also declining. In a report
published by LMC International the sugar cost of production
is 50% higher than the world average cost of production.
The world share of beet sugar has declined from 36% to
25% and the dismantling of government support has started
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in European Union. India can benefit from such world trade
scenario provided the industry is deregulated and becomes
proactive for export of sugar in times of surplus and import
raw sugar in times of domestic deficit.
The present situation of lower domestic production,
tightening stocks and imports is ideal for taking the plunge
- total decontrol. If decontrol is implemented immediately
the impact on sugar prices expected earlier would not be
felt by the industry.
The Government should not defer the dismantling of release
mechanism till October 2005 because the advantageous
position of lower domestic production, tightening stocks
and imports that the sugar industry finds itself in may not
continue till October 2005 and if the Government defers
decontrol the impact of decontrol in on sugar prices either
way could be more devastating.
The first prerequisite of decontrol -commencement of
futures trading in sugar - has already been fulfilled by
NCDEX. Futures trading in Sugar commenced on National
Commodity & Derivatives Exchange Limited (NCDEX)
on July 27, 2004. The Government should now announce
decontrol of sugar industry by way of dismantling the
sugar release mechanism immediately now that futures
trading in sugar is available to the industry on a national
level exchange like NCDEX.
Cyclical sugar production
Sugarcane has a 24 month planting cycle (2 crops of 12
months from same seed) due to which the farmer planting
the crop today faces price risk in 2005 and 2006.
At present no window over such a long time horizon is
available to the farmer, sugar mills at the time of sowing/
processing which can signal the start of excess demand or
excess supply situation through the price movement
resulting out of free demand and supply play.
By keeping prices artificially low or high through sugar
control, price signals do not reach sugar mills and farmers
in time to take appropriate production decisions. The price
signals at present are not reflective of the underlying
demand-supply situation.
NCDEX will offer the long time horizon window through
which such trends shall be visible to the sugar industry
and government alike. At present the Exchange has
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launched contracts in 3 near months, six month forward
contracts pivoting on April and October and once initial
liquidity is captured with the support of Government
support the Exchange shall launch 1 year forward, 18
months forward contracts in due course.
At present
Excess inventory holding costs (over & above the 6
months off season) is
- Rs 1008 Crores per annum
Unhedged Price risk on inventory is
- Rs 1800 Crores if sugar price changes a
rupee per kilo
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Inventory financing consumes the largest chunk of interest
costs and bank limits. Inventory holding cost is 2nd highest
cost factor of sugar mills after cane price. Inability to manage
stocks (and hence market price) has been the single-largest
reason for problems with cane payments. This resulted in
default of cane payments when sugar prices dipped.
NCDEX is working with banks to design sugar specific
commodity financing products where finance will be
available to the sugar mills against their stock holdings
in dematerialized balances.
NCDEX has launched sugar futures contracts in M and S
grade with multiple delivery centres at Kolkata, Chennai
and Delhi so that the sugar mills can benefit from location
arbitrage. NCDEX will continue to evaluate and add
delivery locations on basis of trade flows so that a fine
mix of deficit and production areas are available as
delivery locations. Spot price dissemination for the
multiple delivery locations will signal the deficit markets
to the sugar producers to take logistics decisions.
Signal for EXIM trade decisions
The industry finds itself in the middle of the demand-supply
imbalance. There are no signals ahead of time for the
farmers, producers and government to change their
decisions.
The leverage available to the government/sugar industry
to adjust the shortage in supply by imports of raw sugar in
short run and export of sugar in long run is not being
exploited well in time.
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Domestic futures trading over a long time horizon on
NCDEX can act as an advance signal for EXIM trade
decisions to balance domestic sugar availability and
demand. With current level of duty protection for sugar,
domestic market would be more stable provided surplus
is sent out or deficit is brought in every season. Sugar mills
will bring in raw sugar against future export obligations. It
is akin to borrowing from future surpluses and is a self-
balancing mechanism
If domestic prices rise sharply over world prices , it
makes commercial sense to import
If domestic prices start falling towards world price
levels, there is incentive to export
Intending Importers can use the domestic futures
contracts of sugar traded on NCDEX to hedge their
exposure of sugar in the domestic market over a long
time horizon up to 18 months forward in due course.
Functions of Sugar futures markets on NCDEX
Sugar Futures markets shall provide several valuable
functions:
Elimination of Counterparty Risk
In any transaction, the two parties to the transaction
will trade anonymously on NCDEX. NCDEX provides
a mechanism that guarantees that the contract will
be honoured.
All Sugar trades executed on NCDEX are guaranteed
by NCDEX and the counter party credit risk is assumed
by the exchange. NCDEX manages this risk by a
system of margin collection.
NCDEX also has a robust surveillance system in place
to track illegal or circular trading. This was done to
provide a fair forum for all participants, especially to
retail investors. In the rare case of any defaults by
members, NCDEX has the largest settlement
guarantee fund among all commodity exchanges in
the country.
Hedging Utility
Futures trading markets help transfer risk from one
class of participants to the other.
Price Discovery
NCDEX exists to provide a centralized marketplace
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on a national level where Sugarcane growers, traders,
arthiyas, commission agents, brokers, exporters,
sugar mills, sugar users like process food
manufacturers can discover the price of sugar for
future delivery and shift their risk in sugar prices
moving up or falling down to others who are willing
to bear it.
Consider all there is to know about Sugar on a given
day. The complete set of this knowledge is vast- too
much for any one person to master. These are more
matters of opinion than of counting. Obviously no
person can possess more than a small part of this
information.
The primary function of NCDEX is to provide a
electronic online trading platform where the
Sugarcane growers, traders, arthiyas, commission
agents, brokers, exporters, sugar mills, sugar users
like process food manufacturers will act on his or her
sugar knowledge can make bids and asks. This online
placing of bids and asks results in the market clearing
price of the moment. This is not a flat price. Nobody
sets it. Not even the Government of India. Rather, this
price is discovered in this free-flowing interplay
among all the Sugarcane growers, traders, arthiyas,
commission agents, brokers, exporters, sugar mills,
sugar users like process food manufacturers .
Since the futures prices reflect the collective
perception of the market participants about the future
price level, futures markets provide an important
function of price discovery. In fact the spot price
generally converges to or is close to the futures price
on expiry of the futures contract.
Information Function
Price spread between months which is called
calendar spread gives important information about
storage which is very important for sugar.
Positive calendar spreads or carry spread indicate a
willingness on the part of the market to pay at least
partially for storage- a signal that sugar supply is
plentiful relative to demand and the market feels no
urgent need for a flow of supply.
Negative calendar spread or inverted spreads
indicate that the market demand is much more than
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the supply and thus the market is willing to pay more
for immediate or sooner deliveries. Inverted
deliveries penalize storage and may motivate the
movement of sugar.
Carry spreads are limited to the full cost of carry i.e
cost of storage , insurance, shrinkage and interest for
the specified number of months whereas there is no
limit to inverted spread-inverted spreads can be as
wide as the market pushes it till such time that
movement of sugar begins out of storage.
Spot Price Dissemination
The exchange will be disseminating the spot prices for
sugar three times a day from the locations given below to
its trader workstation, its website and to various data
vendors like Telerate. This will give an indication of the
underlying markets to the sugar industry.
NCDEX is partnering with consumer goods industry players,
rural kiosk network entities, technology companies, news
agencies and banks for both spot and futures price
dissemination. NCDEX will continue to evaluate and add
delivery locations on basis of trade flows so that a fine mix
of deficit and production areas are available as delivery
locations.
Priority center -
M grade contract- Muzaffarnagar
S grade contract- Vashi
Non-priority centers -
M grade contract- Delhi, Kolkata
S grade contract- Chennai, Kolkata
The exchange will be polling/calling up randomly upto 25
market participants from a panel of 40 market participants
and ask them for the prices twice daily. Then after collecting
the raw prices, the exchange will carry out a process called
bootstrapping. Bootstrapping is a scientific procedure of
removing the outliers of raw prices (i.e. prices that are too
far away) and averaging the remaining prices. NCDEX has
outsourced the spot price polling for to CMIE (Center for
Monitoring of Indian Economy). The exchange also invites
spot market players for participating in the spot price polling
process.
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Risk Mitigation at NCDEX
Trading on NCDEX eliminates counterparty risk since
NCDEX is the counterparty for all transactions and
guarantees all trades. NCDEX manages to fulfill this role
through a system of margins collection. Each trade on
NCDEX requires the payment of an up front margin (or
good faith money). Typically this margin is a very small
percentage of the actual transaction value. In addition the
positions on the futures market are marked to market on a
daily basis. The client also needs to pay a daily market-to-
market margin. NCDEX uses SPAN system for calculation
of Value at Risk based margin calculated at 99% confidence
interval over a one-day time horizon. In addition NCDEX
will levy additional margin to cover for extreme movements
or distortions in prices.
NCDEX INFORMATION
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Note
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